How Is Node Operator and Node Validator Income Taxed?

Node operators will most often be taxed the same way as crypto miners. But there are situations where their rewards could be taxed as regular staking income.

Node Income ≠ Staking Income

In the past we’ve discussed how staking rewards are taxed – both currently and how they may be taxed in the future.

But both of those discussions focused on rewards you receive as a delegator. What about if you are a node operator (also referred to as node validators)? Are those rewards taxed the same way? (As always, we’ll preface this by saying that the IRS has not issued any staking-specific guidance yet. These are simply our best guesses based on other rulings).

At first blush, one might think that rewards received as a node operator or staking validator would be taxed the same as rewards received as a delegator, but we’re not so sure that’s the case. Staking delegator rewards are very similar to airdrops. They:

1. Are passive activities with minimal (if any) work required aside from owning the token
2. Are rewards distributed for holding a token
3. Require little to no investment outside of the token itself

However, that’s generally not the case for node validators/node operators:

1. Setting up the node can be time consuming and require ongoing maintenance
2. The rewards received are for the operation of the node and support of the blockchain
3. There can be substantial investment in terms of equipment, server space, internet service, and other costs associated with running the node

Those circumstances make node operation much more analogous to crypto mining, which is taxed as business income.

Fake Nodes May Be the Exception

As a quick aside: crypto is an ever-changing market, so in the future the usage of the term node may change. That’s one of the reasons we’re hedging during this discussion. It’s possible that in the near or distant future there will be “nodes” sold that are so passive that they barely meet the current definition and the parameters that we outlined above.

For instance, let’s say a project sells you a “node” and every day you are rewarded with a set number of tokens. But receiving those rewards does not require a computer or VPS, does not require any ongoing maintenance, and in fact does not even require your node be online at all. You will receive your tokens regardless.

Well, that’s not really a node, is it? That’s an NFT or software license of some kind masquerading as one. In that case, your “node” income would be much closer to income received as a staking delegator and likely should be taxed as such.

How Are Nodes Taxed?

But back to REAL nodes: they are much more similar to crypto mining. And as we covered in our article on crypto mining, mining income is taxed as business income. That treatment has some advantages and disadvantages.

The disadvantages:

1. By default, any profits are subject to self-employment tax of 15.3% (or 2.9% if you’re already maxed out on your Social Security contributions for the year)
2. Those profits are taxed as ordinary income. This is also true of staking rewards and the majority of other crypto income, but pure crypto trading may be eligible for long-term capital gains treatment for trades extending beyond a one-year holding period.

The advantages:

1. The profits may qualify for the 20% Qualified Business Income Deduction (QBI)
   1. QBI is a complex calculation with phaseouts based on a number of different factors. Total personal income, total business income, wages paid from the company, type of entity, depreciable assets held by the company, the nature of the business activity, and a number of other factors all come into play. Maximizing this deduction will require careful planning with your CPA throughout the year, especially if you are a high earner
2. You may elect to have the income taxed through an S-Corp or C-Corp
3. You are allowed to deduct a much wider array of expenses than you are with regular investment income

And again: this is all subject to change. None of this is based on concrete IRS guidance, simply our analyzing the situation and applying tax and accounting principles from other, similar situations.

That said, the tax strategies for node income are more complicated than for other types of crypto income – the same way that actually operating the node is more complicated. You have a lot more flexibility with how you can structure and mitigate that income, but you also have a lot more exposure. Make sure you are planning carefully with your CPA throughout the year to minimize your tax hit.

Any accounting, business, or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.